Extract Private Benefits Research Articles

Efficient and Inefficient Sales of Corporate Control: The Case of Going Private

This paper analyzes the legal rules governing the sale of corporate control in the specific case of going private transactions and examines whether a controlling shareholder must share the premium associated with a sale-of-control. The paper is based on the framework developed in Bebchuk (1994) for analysis of these sale-of-control transactions under the adjusted market rule (AMR) that enables constitution of different rights for the controlling shareholder and the minority shareholders and under the adjusted equal opportunity rule (AEOR) that provides equal rights to the minorities and the controlling shareholder. The paper’s main findings are that both the AMR and the AEOR prevent inefficient transfers, since the new controller fully internalizes the externality imposed by extracting private benefits of control under both rules. However, the AMR is superior to the AEOR in facilitating efficient transfers. This is because the AEOR can prevent efficient transfers, due to the higher price demanded from the buyer in order to compensate both majority and minority shareholders. As a consequence, overall, the AMR dominates the AEOR for transactions in which a company is taken private.

Insider Ownership and the Cost of Debt Capital: Evidence from Bank Loans

Agency theory predicts that the incentives for insiders to extract private benefits at the expense of creditors are negatively related to the level of ownership retained by insiders. However, the ability of insiders to effectively control the resources of the firm and engage in such activities is positively related to their level of ownership. Using a large international sample of bank loans, this paper demonstrates how these two contrasting forces result in an inverse U-shaped relationship between insider ownership and the firm’s cost of borrowing. Consistent with the control argument, the positive relationship between insider ownership and cost of debt for low levels of insider ownership is found to be not in place when insiders are entrenched above and beyond their level of ownership. Finally, the relationship between insider ownership and cost of debt in presence of loan contract clauses is addressed.

Excessive CEO compensation and performance in French family firms

The purpose of this paper is to examine the effects of CEO compensation on firm performance of French family firms. To investigate the link between executive pay and firm performance, we used multiple regression method over a period of four years (2007 to 2010). Our results show that French family companies provide excessive compensation compared to their non-family counterparts, suggesting that families are likely to extract private benefits at the expense of minority shareholders. The findings also show that excess remuneration paid to executives has a negative impact on financial performance. This result confirms the preceding one and suggests that CEO compensation is used by families as a tunnelling mechanism that exacerbates agency costs.

Private Benefits of Control, Ownership Structure, and CEO Turnover: Evidence from East Asia

Using a sample of firms from nine East Asian countries over 2006-2010, we find that CEO turnover is less related to poor performance when firms have shareholders with large ultimate control rights or when the control divergence (i.e., larger voting than cash flow rights) is high. These results imply that controlling shareholders prefer not to adopt or enforce a performance-based disciplinary scheme to evaluate the CEOs in facilitating the extraction of private benefits. As predicted, we also find that such an agency problem is stronger for firms in countries with weak investor protection than in countries with strong investor protection. We further document that the ultimate control position drives this type of problem for state-controlled firms, but the control divergence manifests the agency problem for family-controlled firms.

Shareholder Proposals in the Market for Corporate Influence

The period from 2003 to 2013 shows a remarkable shift in the use and effectiveness of shareholder proposals. Shareholders pursued many different types of proposals over the decade, eight of which are identified in this article as most important to corporate governance. The article then provides evidence on how these proposals were used and voted on by shareholders, helping to provide clarity to the role of shareholders in corporate governance. The evidence presented in this article shows that shareholders are increasingly willing to pursue proposals which enhance the accountability of managers. However, reflecting legitimate concerns with the risk of empowering minority shareholders who do not owe fiduciary duties to their fellow shareholders, voting patterns reveal that shareholders are cautious in how they allocate power. While most shareholders support measures that facilitate managerial discipline, they are more cautious in their support of proposals that empower other investors and augment their influence over managers. This article develops a theory of shareholder voting by suggesting that this behavior reflects shareholder concern over two types of costs. First, the majority of shareholders operate under information cost constraints as diversified investors that generally have significant informational asymmetries with respect to management. Therefore, such shareholders will tend to seek low-cost signals of firm performance, which would predict support for disciplining proposals that allow shareholders to key off basic financial performance measures such as market price; indeed, as other scholars have noted, the majority of shareholders are most interested in defensive, ex-post activism that reduces managerial entrenchment and exposes managers to the market for corporate influence and corporate control. Second, the significantly lower levels of support for empowering proposals may be explained by common agency costs — costs that arise as numerous shareholder-principals seek to influence a single set of manager-agents. The significant empowering proposals identified in the article have a common feature: they all promote shareholder influence in excess of a commensurate economic interest held by the activist shareholder. This raises concerns that activist shareholders will attempt to use their influence to extract private benefits at the expense of the other shareholder-principals. However, most shareholders appear to recognize the threat presented by a common agency in which small block holders are empowered to influence management, and such proposals receive significantly less support.

Ownership structure and divestiture decisions: Evidence from Australian firms

Divestitures create shareholder value by helping firms to optimize their portfolio of assets. However, firms may forego value enhancing divestitures because of agency problems. More specifically, large controlling shareholders may prefer to retain the assets in order to extract private benefits of control at the expense of minority shareholders. In this paper, we explore the role that other blockholders play in constraining the largest shareholder's influence. The results indicate that divestiture activity decreases with the ownership of the largest shareholder. The presence of another significant blockholder appears to curb this negative bias towards divestitures. Our findings provide an economic rationale for the higher performance of firms characterized by more balanced ownership structures. Involvement of family owners also appears to provide similar benefits.

Management entrenchment and the valuation discount of dual class firms

• Dual class firms are discounted compared to single class firms with concentrated ownership. • Dual class CEOs and directors have a longer tenure than their counterparts in single class concentrated control firms. • Longer CEO and director tenure conditional on dual class firm underperformance is consistent with managerial entrenchment. • The paper provides evidence that the greater the degree of entrenchment, the larger the dual class discount. Prior studies provide empirical evidence that dual class firms are discounted compared to single class firms due to the extraction of private benefits. This study examines the link between managerial entrenchment and the dual class discount. Using propensity score matching and conditioning for past underperformance, the paper shows that investors apply a greater discount to the value of dual class firms as the degree of managerial entrenchment increases. The impact of entrenchment on dual class discount is more pronounced when the CEO is the controlling shareholder compared to when the controlling shareholder is a director or the chairman of the board.

Blockholders and Corporate Governance

This paper reviews the theoretical and empirical literature on the channels through which blockholders (large shareholders) engage in corporate governance. In classical models, blockholders exert governance through direct intervention in a firm’s operations, otherwise known as “voice.” These theories have motivated empirical research on the determinants and consequences of activism. More recent models show that blockholders can govern through an alternative mechanism known as “exit”—selling their shares if the manager underperforms. These theories give rise to new empirical studies on the two-way relationship between blockholders and financial markets, linking corporate finance with asset pricing. Blockholders may also worsen governance by extracting private benefits of control or pursuing objectives other than firm value maximization. I highlight the empirical challenges in identifying causal effects of and on blockholders as well as the typical strategies attempted to achieve identification. I close with directions for future research.

Ownership concentration, top management and board compensation

The degree of ownership concentration may influence executive and board compensation (Bebchuk & Fried, 2003). This article analyzes this relationship. Detailed information about top management and board compensation became available starting in 2010 through new Securities Commission filings. Linear regression models applied to a sample of 315 Brazilian companies traded on the national exchange indicate a negative and statistically significant economic correlation between executive compensation and the degree of ownership concentration. Ceteris paribus, companies with a lower degree of ownership concentration pay higher compensation to top executives. Family controlled companies pay more to their chief executive, but not to the managerial team as a whole, and the compensation of directors increases with a greater proportion of control group members or their relatives on the board. There was support for the Managerial Power Hypothesis in companies with a lower degree of ownership concentration and for the extraction of private benefits in companies where it is greater.

Corporate Governance and Firm’s Cash Holdings: Evidence From India

This paper investigates the empirical determinants of corporate cash holdings for Indian firms. A sample of 1540 unique non finance and non utility Indian firms, with positive assets and positive sales, listed on the National Stock Exchange for a period of 11 years, (from 2001-2011) is selected. We study cash holdings in family business companies, foreign origin companies, Government companies, Private companies and in Group companies. We focus on the effect of ownership structure on firm governance. Corporate governance theories suggest that firms with high levels of concentrated ownership are subject to greater extraction of private benefits from cash holdings. We present evidence of a significant relation between promoter’s ownership and cash holdings. Results reveal that Indian firms with high level of family ownership and group companies have low cash holdings whereas Government companies, Private companies and Foreign origin companies have larger cash holdings suggesting more opportunities for private benefits extraction. The findings of this paper show that corporate cash holding is influenced by market to book ratio, net leverage, net working capital, size, R&D to sales, ROA, and capital expenditure to assets. Dividend dummy and cash flow volatility are found not significant.

Block Trade Targets in China

We examine characteristics associated with the probability of Chinese companies being block trade targets. We find that the probability decreases once a company has completed its split-share structure reform, and thereby, substantially decreases non-publicly tradable shares. Accordingly, block trade costs increased significantly after the reform. Firms with less concentrated (well-balanced) ownership structures are more likely to be block trade targets, and bidders pay low costs to obtain control rights of those companies. Finally, bidders tend to target small companies with low directors’ ownership. In China, bidders are likely to target companies that provide new controlling shareholders a low-cost opportunity to extract private benefits.

Ownership Structure and Divestiture Decisions: Evidence from Australian Firms

Divestitures have the potential to create shareholder value by helping firms optimize their portfolio of assets. Even so, firms do not necessarily take up divestitures because of agency problems. In fact, large controlling shareholders may prefer to extract private benefits of control at the expense of minority shareholders. In addition, divestitures may expose the misappropriation of corporate resources. In this paper, we explore the role that other blockholders play in constraining the largest shareholder’s influence. The results indicate that divestiture activity decreases with the ownership of the largest shareholder, which imposes a cost to minority shareholders since the firm’s value is not maximized. The presence of another significant blockholder appears to curb this negative bias towards divestitures. This finding provides an economic rationale for the higher performance of firms characterized by more balanced ownership structures. Involvement of family owners also appears to provide similar benefits.

Noise Adopters in Corporate Governance

This Article argues that “noise adopters,” namely firms whose corporate governance is determined by non-substantive factors such as attorneys’ boilerplates, network externalities, and mere inertia, provide camouflage to insiders with a strong preference for entrenchment. Normally, a deliberate choice of entrenching governance terms could signal weak market discipline and high extraction of private benefits. Yet, since some firms stagger their boards or incorporate in their home state almost randomly, these choices send only a noisy signal, and in turn result in only a partial market discount of firm value. Entrenchment-seeking managers can achieve their desired level of entrenchment without paying a full price. This analysis highlights informational limits on markets’ ability to perfectly price corporate governance terms. The value of governance terms varies across firms due to unobservable variations in market forces, and potential signaling is obscured by practices of random adoption. Noise adopters influence patterns of adoptions and help explain puzzling evidence regarding pricing and adoption of governance terms.

Influence of Institutional Structures and External Governance Mechanisms on IPO Firms

Initial public offerings (IPOs) provide attractive research context for governance related studies due to high levels of information asymmetry, adverse selection and moral hazard (Certo et al, 2009). However, most studies have largely focused on the linkage between governance indicators and underpricing of IPOs. This paper extends and builds on prior literature by studying how differences in country- level governance affect the valuation and performance of IPOs. Examining data from 6,078 IPOs from 46 countries from 2003 to 2007, we find an interesting dichotomy in the results where firm valuation (market-to-book) is positively and significantly related to better country-level governance indicators but firm operating performance (ROA) is negatively and significantly related to better country-level governance indicators. These results support the conjectures associated with institutional theory and agency theory wherein investors value IPO firms positively in countries with better governance indicators and IPOs face decline in their operating performance in the initial years post-IPO due to increased agency costs as firms transit from private to public, higher governance costs and higher costs of extracting private benefits in countries with better governance indicators. These results are also indicative of the need for more work examining the linkage between micro-level firm issues and macro-level country governance issues.

Shareholder Protection and Outside Blockholders: Substitutes or Complements?

Should outside blockholders be more common in countries with weaker shareholder protection? I show that there can be a U-shape dependence of the outside ownership concentration on the quality of shareholder protection. This result is in line with the recent empirical evidence questioning the traditional law-and-finance view. In my model, a lower cost of private benefit extraction makes outside monitoring less desirable for an entrepreneur, thereby calling for a smaller outside blockholder's share. However, a low blockholder's share may provoke collusion between the entrepreneur and the blockholder, which hampers raising funds from dispersed shareholders. This trade-off yields the described U-shape relationship.

Lessons from the French Exception: How Firms Choose between Unitary and Dual Boards

Many governance reform proposals focus on strengthening board monitoring. In contrast, Adams and Ferreira (2007) and Harris and Raviv (2008) conclude that a passive board is often optimal. We examine determinants of board structure choice in France, where firms are free to choose between a unitary (passive) board and a dual (monitoring) board. We find firms with greater asymmetric information are likely to adopt a unitary board. Firms with a high potential for private benefit extraction are likely to adopt dual boards. Firms well monitored by financial market and institutional forces are less likely to have dual boards. Our results imply that freedom of contract about board structure is valuable for shareholders.

Political Motivation, Over-Investment, and Firm Performance

We show that executives in the Chinese listed firms make politically motivated investments to build political ties. We also find that excessive investments are more pronounced in firms that can benefit more from political connections (e.g., private firms and poorly governed firms). Although such investments are largely inefficient, and adversely affect firm performance, we find that political connections allows firm owners/executives to extract private benefits including tunneling resources, fast growth in wealth, and promotion to higher positions. Our results are robust to competing hypotheses, alternative measure of abnormal investments, the propensity score matching method, analysis of alternative samples, and the instrumental variable approach. Our study suggests that understanding the means through which political connections are built helps reconcile the mixed economic effects of political connections.

Corporate Governance in Family Firms

This paper reviews the theoretical and empirical literature on the corporate governance in family controlled firms. In particular, it discusses conficts of interest between owner and manager (referred to as Agency Problem I) as well as between minority and large shareholders (referred to as Agency Problem II) among family frms under agency theory framework. It is widely believed that families are better monitors of managers than other types of large shareholders, suggesting that Agency Problem I are less prevalent in family than in non-family frms. On the other hand, it is also argued that controlling families may extract private benefits at the expense of minority shareholders. In addition, the governance literature indicates that several conventional governance tools for controlling Agency Problem are less efective in dealing with Agency Problem II. Keywords: Agency problems, corporate governance, family control, boards of directors

An agency theory explanation of SEO underperformance: Evidence from dual-class firms

Using a sample of U.S. dual class companies, we empirically investigate the effects of the divergence between insiders’ voting and cash flow rights on market reaction to seasoned equity offerings (SEOs) and long-run stock performance following SEOs. We find that SEO announcement returns and long-run stock performance following SEOs are negatively related to measures of the divergence between insiders’ voting and cash flow rights. Our results support the view of agency theory as a plausible explanation of SEO underperformance. Misalignment of interests between insiders and outside shareholders can create managerial incentives to undertake value-destroying investments to extract private benefits, ultimately leading to a reduction in firm value.

Excess Control Rights and Corporate Acquisitions

The typical French listed company exhibits a concentrated ownership structure with the largest shareholder typically holding more voting rights than cash flow rights. This paper studies the acquisitions made by French listed firms over the period 2000 through 2009 and investigates how such ownership characteristics affect acquirer abnormal returns and acquisition activity. Abnormal returns around acquisitions are decreasing as the wedge between voting and cash flow rights increases. This result suggests that controlling shareholders use corporate acquisitions as a means of extracting private benefits at the expense of minority shareholders. The well-documented valuation discount associated with the divergence between voting and cash flow rights could be explained by less efficient acquisitions. The paper also shows that firms whose largest shareholder holds significant excess control rights are less likely to engage in M&A activity. This last finding raises the issue of sample selection bias, which has not been taken into account in earlier studies.